Inverse ETFs Face Cap Gains of as Much as 80%

More than 40 inverse exchange-traded funds run by Rydex Investments and ProFunds are passing on sizable capital gains to investors. For those who hold those funds in taxable accounts, the taxes they will owe will range from 50% to even as high as 80% of assets, The Wall Street Journal reports.

Large investors, who are able to redeem ETF shares for underlying stock holdings rather than cash, are typically able to avoid capital gains.

But this year, due to the extremely poor performance of the stock market, those ETFs that short stocks have delivered substantial returns, and issued large payouts in December. Unlike regular ETFs, these inverse funds invest heavily in swaps and futures, for which there are no in-kind stocks to deliver to investors. Thus, the Rydex Inverse 2x S&P Select Sector Energy ETF, for example, unleashed capital gains of 86.6% of its net asset value.

Investors could have avoided the capital gains taxes had they sold their shares ahead of the distribution, but many of the funds failed to give investors advance warning for fear that many would bail out, leaving remaining investors holding the bag.